How to Fix Your Credit to Buy a House: A Step-by-Step Guide
The Importance of Good Credit When Buying a Home
Buying a house is one of the biggest financial decisions you’ll ever make – and having good credit is crucial. Your credit score plays a major role in determining whether you’ll be approved for a mortgage, and what interest rate you’ll pay. A higher credit score means you’re a lower risk to lenders, so you’ll get better rates and terms. On the other hand, a low credit score can make it really tough to get approved at all, or saddle you with a much higher interest rate that’ll cost you tens of thousands more over the life of the loan.So if your credit isn’t looking so hot right now, don’t worry – there are steps you can take to improve it before applying for a mortgage. It’ll take some time and effort, but getting your credit in shape can save you a ton of money in the long run. Trust me, it’s worth it.
First Step – Check Your Credit Reports
The first thing you need to do is get copies of your credit reports from the three major bureaus – Experian, Equifax, and TransUnion. You can get free annual reports from each bureau once per year. Go through them line-by-line and look for any errors or negative items that are dragging your score down.Errors on credit reports are way more common than you’d think. According to a study by the FTC, one in four Americans has at least one error on their credit report that could impact their score. Yikes!Common errors include:
-- Accounts that don’t belong to you
- Incorrect payment statuses (e.g. marking an on-time payment as late)
- Same debt listed multiple times
- Outdated negative info that should’ve dropped off
If you find any errors, you’ll need to dispute them with the credit bureaus. This can be a bit of a hassle, but getting that negative stuff removed can really help boost your score.
Next – Work on Paying Down Debt
The second biggest factor affecting your credit score is your debt-to-income ratio – in other words, how much debt you have compared to your income. Lenders want to see that you have enough income to comfortably cover your monthly debt payments, including the new mortgage.So paying down as much existing debt as possible before applying for a home loan is crucial. Focus first on paying off any delinquent or defaulted accounts, then start chipping away at credit card balances. The lower you can get those revolving balances, the better.You may have heard of the “credit utilization ratio” – that’s the percentage of your total available credit that you’re using at any given time. For example, if you have three credit cards with a combined limit of $30,000 and you have $10,000 in balances, your utilization is 33%. Most experts recommend keeping your utilization below 30% for the best credit score impact.It can be tough, but doing things like:
- Paying more than the minimum on cards each month
- Asking for higher credit limits (without prompting a hard inquiry)
- Putting extra money toward debts using the debt snowball or avalanche methods
…can really help get that utilization down and improve your credit profile for mortgage approval.
The Debt Snowball vs Debt Avalanche Methods
Speaking of debt payoff methods, you’ve got two main options – the debt snowball and the debt avalanche:
-The Debt Snowball
- List out all your debts from smallest balance to largest
- Pay minimums on everything except the smallest debt
- Throw all extra money at the smallest debt until it’s paid off
- Then roll that payment amount onto the next smallest debt, and so on
The psychological wins of knocking out those smaller balances first can help you stay motivated.
The Debt Avalanche
- List out all debts from highest interest rate to lowest
- Pay minimums on everything except the highest interest debt
- Throw all extra at the highest interest debt until it’s paid
- Then roll that payment to the next highest interest debt
This method helps you get out of debt faster by prioritizing the most expensive debts first. But it can be harder to stay motivated early on.There’s no definitively “better” method – it comes down to your personal preference and money mindset. But either approach, applied consistently, can have a big impact on your debt levels and credit utilization.
Be Careful About Closing Old Accounts
One common credit myth is that closing unused credit card accounts will help your score by lowering your overall credit limit and utilization. But this can actually backfire in a couple ways:
-- It can shorten your overall credit history, since the age of your oldest account is a scoring factor. An older average age is better.
- It lowers your total available credit, which can increase your overall utilization ratio even if your balances stay the same.
So unless an old account has an annual fee you really want to avoid, it’s usually better to keep paid-off accounts open and let them season. Just cut up the cards if you’re worried about using them again.
Build Your Credit Mix
Another factor that makes up a small but important part of your credit score is your “credit mix” – in other words, the variety of credit products you have. Having a mix of revolving credit (like credit cards) and installment loans (mortgages, auto loans, personal loans, etc.) can help demonstrate your ability to manage different types of credit responsibly.If you only have credit cards currently, you could consider taking out a small personal loan and paying it off as agreed to add an installment loan to your credit report. Or ask about being added as an authorized user on someone else’s installment loan account.Just be careful about applying for too much new credit at once, since each application can result in a hard inquiry that may temporarily ding your score a few points.
Be Patient and Persistent
Unfortunately, there’s no magic overnight fix for bad credit. Negative items can remain on your credit reports for up to 7-10 years. But every positive step you take – paying bills on time, keeping balances low, adding a mix of credit – can help offset the impact of those negative items over time.It’s absolutely possible to go from a poor credit score to an excellent one, but it takes diligence and patience. If you stay the course and develop good long-term credit habits, you’ll see your score steadily improve month after month.
-How Long Does It Take to Fix Credit for a Mortgage?
There’s no set timeline, since it depends on what specifically is hurting your credit. But in general, most experts recommend taking the following steps at least 6-12 months before applying for a mortgage:
- Obtain your free annual credit reports and dispute any errors
- Pay down revolving debt to get credit utilization under 30%
- Catch up on any past-due accounts or outstanding collections
- Consider taking out a small loan to build an installment history if needed
Following those steps consistently for 6 months to a year can make a big difference in getting your credit into qualifying territory for a mortgage.
Credit Repair Services – Are They Worth It?
You’ve probably seen tons of ads for credit repair companies that claim they can quickly and easily fix your credit for an upfront fee. While there are some legitimate services out there, be very wary – the credit repair industry is rife with scams that overpromise and underdeliver.The truth is, there’s nothing a credit repair company can legally do that you can’t do yourself for free. They don’t have any special ability to remove accurate negative info from your reports. The most they can do is:
- Obtain your credit reports and analyze them
- Dispute questionable or incorrect negative items
- Provide credit education and advice
So while a good credit repair service can save you some time and hassle, they can’t perform any magic tricks. And many of them charge hefty upfront fees or monthly subscriptions that may not be worth it.If you do decide to use a credit repair company, make sure to research them thoroughly first. Check reviews, complaint records with the Consumer Financial Protection Bureau, and make sure they are complying with laws like the Credit Repair Organizations Act. Avoid any company that:
- Demands money upfront before providing any services
- Guarantees to remove all negative items, even accurate ones
- Tells you to dispute information you know is correct
- Advises you to invent a “new credit identity” or engage in other illegal acts
Reputable companies will provide a written contract, allow you to cancel within a few days, and only charge after they’ve actually performed services. But you may be better off just handling the process yourself.
DIY Credit Repair Tips
If you want to take the DIY credit repair route, here are some tips:
- Get organized with a file folder or binder for all your credit documentation
- Request your free annual reports from annualcreditreport.com and check them carefully
- Use the sample dispute letter templates from the FTC or CFPB to dispute errors
- Send your dispute letters via certified mail and keep copies of everything
- Follow up with the bureaus if they don’t respond within 30 days
- Consider signing up for a free credit monitoring service to track your progress
- Be persistent – it may take multiple disputes to get an error corrected
It can be tedious, but doing your own credit repair allows you to save money and have full control over the process. Just be prepared to put in some time and effort.
When to Apply for a Mortgage
Once you’ve been steadily working on your credit for 6-12 months, it’s probably a good time to start mortgage shopping. Get pre-approved with a few different lenders to see what rates and terms you qualify for based on your current credit profile.Don’t be discouraged if the rates aren’t as low as you’d hoped – remember, your credit is just one factor lenders consider. Your income, employment, down payment amount, and the home’s value also play a big role.If the rates you’re being quoted seem too high based on your credit, you may want to hold off a bit longer and keep working on improving your score. An extra 20-40 points could make a meaningful difference in the interest rate you get.But if you’re pleased with the offers, go ahead and pick a lender to start the official mortgage application and approval process. Just be aware that there will likely be another “hard inquiry” that could temporarily ding your score a few more points when you officially apply.
Mortgage Options for Less-Than-Perfect Credit
Even if your credit isn’t perfect, you may still have some good mortgage options, especially if your income and down payment funds are solid:
FHA Loans – Backed by the Federal Housing Administration, FHA loans allow credit scores as low as 500 with a 10% down payment, or 580 with just 3.5% down. More lenient underwriting requirements make FHA loans a good option for borrowers with bumpy credit.
VA Loans – For military borrowers and veterans, VA loans don’t have a minimum credit score requirement. However, most lenders impose a minimum of around 620.
USDA Loans – For rural homebuyers meeting income limits, the USDA loan program allows 100% financing regardless of credit score.
Non-QM Loans – Some non-qualified mortgage (non-QM) lenders may approve borrowers with lower credit scores, but at higher interest rates to compensate for the risk.So don’t assume you’re automatically disqualified from getting a mortgage just because your credit isn’t perfect. As long as you can demonstrate the ability to repay through income, assets, and down payment funds, you may still have options.
H2: Maintaining Good Credit After Buying a Home
The work doesn’t stop once you finally get approved for that mortgage. Developing and maintaining good long-term credit habits is crucial for keeping your credit in shape after buying a home.Here are some tips for maintaining good credit as a homeowner:
- Make your mortgage payment on time every month – payment history is still the biggest factor
- Keep credit card balances low – under 30% utilization is ideal
- Limit applying for new credit – too many hard inquiries can ding your score
- Check your reports annually for any new errors or issues
- Consider credit monitoring to stay on top of your credit profile
Good credit doesn’t just help with getting approved for a mortgage – it can also help you qualify for better rates on other loans, credit cards, insurance policies, and more. So staying vigilant about your credit health has lots of benefits.
The Bottom Line
Fixing your credit to buy a house does take some effort, but it’s absolutely worth it in the long run. By taking steps like:
- Checking your reports for errors and disputing any mistakes
- Paying down debts to lower your credit utilization
- Adding different types of credit to your mix
- Being patient and letting your good habits compound over time
…you can steadily improve your credit profile and increase your chances of getting approved for a mortgage with a competitive interest rate.It may seem daunting, but breaking it down into manageable steps makes it much more achievable. And the money you’ll save on your mortgage by having good credit will make all the effort worthwhile.